Upfront cash and cashflow from Apple’s rumored iPhone in China deal

Washington Post’s Tameka Kee reports that Apple’s rumored 5 million iPhone sale to China Unicom will generate about $100 per unit in profit for Apple. Kee states that this is less than the estimated $400+ per unit that Apple now gets on its deal with AT&T. My reaction … “Um, yeah … no kidding” … We’re not on a level playing field in China. We need to get a toehold in China, with some 700 million wireless consumers, and then go from there. Besides this deal is far more profitable than the initial margin calculations suggest.

Let’s do a quick breakdown … iSuppli has a BOM estimate of $178.96 for the iPhone 3GS. The report from CBN states that Apple’s iPhone deal with China Unicom is for 5,000,000 iPhones purchased upfront for $1.46 billion. That’s $292 per unit less the $178.96 = $113. But there are other variables to consider. Apple will almost certainly NOT be providing China Unicom with the standard iPhone 3GS model. The special model for China will likely be the new model A1324 and it will likely cost less to build and distribute. If numerous reports are to be believed, this model will not include WiFi (a $5 to $10 savings per unit). Moreover, it is likely that China Unicom will cover virtually all shipping, marketing and distribution expenses associated with a China iPhone launch. So you can knock off another $18 to $25 per unit in expenses that Apple would normally incur.

Whether Apple will receive ongoing App Store and iTunes revenues under this China deal is a large question mark? Pure conjecture on my part, but I would not be surprised to learn that Apple has assisted China Unicom with the development of a China Unicom branded version of Apple’s App Store and iTunes. A bit more background and flat out guesswork …

Li Yizhong - MIIT VM

Apple’s China iPhone negotiations have ostensibly been with potential carrier partners (first China Mobile and later China Unicom), but the watchful parent has always been in the background whispering instructions into the child’s ear. It is my view that China’s Ministry of Industry and Information Technology (MIIT) has had the final say on the iPhone deal terms. And it’s apparent that China’s MIIT has no intention of allowing Apple, or any handset manufacturer for that matter, to capture substantial wireless value added services (WVAS) revenues that China feels belong to its indigenous carriers. Consequently, to get any iPhone deal done in China, Apple may have been required to give up a large portion of revenues from the Apple iPhone platform (iTunes and App Store). That does not mean “no apps” or music for China iPhone owners. It just means a different platform, one with China Unicom’s brand. This will likely be a cloned version of Apple’s platform designed by Apple for China Unicom. I believe that Apple will be (shhhh … quietly) “cut in” for a certain percentage of WVAS revenues despite all of the posturing in the China tech press that “Apple will forego its revenue sharing model.” Since saving face is very important in China, I expect that Apple will not publicly disclose any assistance they may provide to China Unicom in developing their special iPhone WVAS platform, and nor will they publicly identify (break out) revenues from this WVAS partnership.

As with most Apple ventures, the iPhone deal in China will prove to be handsomely profitable and cash will continue to accrue to Apple’s bottom line … starting with a cool $1.46 billion up front!

5 million iPhone package sale to China Unicom? Carrefour to be a key iPhone distribution partner?

Update – August 13, 2009: According to the Associated Press, China Unicom spokesman Yi Difei has denied the reports of an iPhone deal and large iPhone pre-purchase. Yi Difei stated “The report is not true.”… “There are all kinds of possibilities. There is no particular timetable for the talks.” Despite this denial, Zhou Fang, the CBN reporter who broke the story, discounts the China Unicom denial and noted that he had made audio recordings of the interviews with the Guangdong Unicom executives (Zhou Youmeng and Yu Zaonan) who spilled the beans.

Adding further legitimacy to the original CBN report is a post today on Interfax TMT and the news today from a Carrefour source. Chongqing Evening News, quoting a Carrefour employee, states that the iPhone in China deal is a go and Carrefour would indeed be part of the distribution plan. The report states that iPhones could be ready to go on sale as early as late August and that Carrefour stores in Guangzhou and other costal areas have begun preparing store displays.

August 11, 2009: According to an August 11 report in China’s CBN.com(China Business News), China Unicom has agreed to pre-purchase for inventory five million (5,000,000) special “for China” iPhones from Apple. The report states that China Unicom will pay Apple 10 billion CNY (USD $1,463 billion) or 2,000 CNY (USD $292.60) per unit, and that China Unicom will have a 3-year iPhone exclusive in China. CBN cites Guangdong Unicom’s Deputy General Manager Zhou Youmeng, as a prime source for this story.

Guangdong Unicom is a subsidiary of Beijing-based China Unicom. China Unicom’s subsidiaries are often quite independent and don’t always check with the parent in Beijing before launching marketing initiatives or speaking (leaking) to the media. Shanghai Unicom had their wrist slapped rather severely for comments to reporters re the rumored “iPhone deal” and for their publication of iPhone images on their subsidiary website back in March. It will be interesting to see how Beijing handles this latest leak by the Guangdong subsidiary. NOTE: Guangdong/Canton is China’s most populous region with over 150 million people.

CBN reports that China Unicom employees have been training on thenew model iPhone for China Unicom and it will be ready for launch in September. CBN also claims that Carrefour (134 superstores in China) will be a key iPhone distribution partner in China.

Marbridge Consulting reports that the new model iPhone for China was spotted by reporters attending the signing ceremony for China Unicom’s agreement with Carrefour. The new iPhone was apparently on hand as one of several 3G handsets that will be sold for China Unicom through Carrefour superstores.

Another source for the story, Yu Zaonan, a manager in Guangdong Unicom’s individual client department, stated that the iPhone will be priced at 2,400 CNY (USD $351) for an 8GB iPhone and 4,800 CNY ($702) for the 16GB model. Zaonan qualified his comments to CBN by stating that this plan was contingent on the formal signing of the deal by Apple and China Unicom in Beijing.

With Greg Joswiak’s (Apple VP for iPhone Product Marketing) very recent trip to China, it appears that the “iPhone in China” deal may soon become more than just a hot rumor. 5 million iPhones will be, by far, Apple’s largest single iPhone package sale.

The following is my reply to Artman’s post (quote below) on the terrific AAPL Sanity message board. Artman is referencing Tim Cook’s careful choice of words when asked when iPhone might be launched in China. Twice now Tim Cook has stated that Apple’s objective is to have iPhone officially in China “within a year.”(i.e. could be tomorrow… or 12 months from now)*******************

And that’s a wise quote to keep in mind Artman … As Yogi Berra often admonished “nothing is done till it’s done!”(a bit of a paraphrase)

In my last post I listed a few of the issues that could still be on the Apple/China Unicom negotiation table (won’t repeat here).

When I think about the China iPhone negotiations, I think about how much is controlled by the the “powers” looking to protect “greater interests” in China. I’m reminded of my pick-up basketball games down at the local gym. The same guys show up every Saturday … Teams get picked and the competition is fierce. It’s human nature to want your team to win, and you’ll fight like crazy to score big and shut down your opponent. But when the game is over, everyone, no matter the team they were on, is still good friends. Next game, the guy you battled and elbowed may be your own teammate. And when a stranger shows up at the gym and “has game,” you want that guy (Apple) on your team. But no matter how well the stranger can play, he won’t supplant the relationships with the guys you’ve known for years.

In China’s telecom industry, the wireless carriers compete like crazy, but everyone knows each other very well and they are always very mindful that the telecom industry comes first … and if necessary State authorities will remind carriers that China’s telecom industry comes before any one company’s immediate self-interest.

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So you can draft a great “outside player” (Apple) to help you win the game … but if authorities perceive that the industry might suffer or lose face (outside player commands too much attention and boosts pay for players vs team owners), then the game can and will be rigged.

Long way around to my point … which is that China is not making things easy for Apple, an outside player that has “serious game.” China’s ministries want to bring their own carriers’ “game” (value-added services platforms) up to Apple’s level and/or otherwise constrain Apple’s game. No WiFi for you Apple! Only China’s WAPI standard. Want to offer wireless value-added services on your own iTunes/App Store platform? Might take awhile to approve that.

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All that said … there are multiple parties in China who have serious economic interests in a prompt and successful launch of iPhone, including:

Apple China

China Unicom/vsnes.com

Foxconn (Hon Hai Precision)

Best Buy China – probable iPhone distributor

Wal-Mart China – possible iPhone distributor

Plenty of money will be spent on an iPhone launch … “Net net” iPhone in China will be good for China’s economy

Sina.com is reporting this morning that Greg Joswiak, Apple VP for iPhone Product Marketing, will lead a team from Apple on an iPhone mission to China. Touch down in Beijing is rumored to be later this week. Sina.com suggest this trip will be a restart of iPhone negotiations. The literary will include meetings with China Unicom and discussions with China’s telecom authorities.

iPhonAsia wonders whether this is less a “restart of talks” and more a finalization of key marketing and distribution plans? There has been growing evidence of progress along the iPhone to China path including possible production of a new iPhone model (A1324) for China.

Conversations with MIIT over WiFi on iPhone. Will a launch delay to year-end enable Apple to submit a WAPI/WiFi iPhone for fast-track testing/approval? Or will Apple go with (as rumored) a special customized for China iPhone without WiFi?

Obtaining the all important network access license (NAL) from China’s Ministry of Industry and Information Technology (MIIT).

There has been some recent buzz (previous Sina.com article) over the possibility that Apple may be ceding delivery of apps and music to China Unicom’s “Wo” (3G services brand name) platform. Translation from Sina.com post:

“It is worth noting that it did not configure the Apple iPhone’s WiFi global functions, the process of random incidental nor with iTunes Music Store, as well as store applications (App Store).”

China’s telecom industry, supported by their regulatory authorities, may have demanded this concession to protect “carriers’ interests.”

Paying for music in China is a novelty (free downloads are the rule). Very few in China have credit cards and payment for value-added services may need to be integrated with China Unicom payment systems.

China Unicom is rumored to be providing generous subsidy plans for iPhone (selling iPhone below the price they pay to Apple per unit). This suggests that they will need to make up revenues from higher plan rates and/or value-added services fees.

Why Apple may have drawn the line in the proverbial sand and insisted that Apple retain control over their China App Store and iTunes**:

iPhone’s reputation is a reflection of its entire ecosystem, which includes Apple’s wireless valued-added services (WVAS) such as the App Store and iTunes. China Unicom has a long way to go in building out their own WVAS platform. Integration between iPhone and its WVAS platform needs to be seamless not kluge.

I’m cautiously optimistic that an iPhone deal will be concluded soon and I view Apple’s latest trip to China as a positive sign. My guess for a China iPhone “deal signed” announcement date is late Summer with a launch in the Fall of 2009.

Footnotes:

* China Unicom will have solid WCDMA 3G coverage in all major cities by Fall. They are spending big to accomplish this mission. China Unicom plans to have 125,000 base stations up by year-end. That’s more 3G base stations than all the operators in Western Europe have rolled out in the 9 years since the 3G wireless standard has been in existence.

** There is a chance that Apple might create a clone of their iTunes and China App Store and simply re-brand it for China Unicom. This will allow China Unicom to save face and still allow for a seamless integration between iPhone and its platform.

Not a major revelation … just one more piece of the puzzle falling into place … According to dycj.ynet.com (reported via Trading Markets), retailer Best Buy Co., Inc. (NYSE: BBY) will introduce 3G products and services of China Unicom at its franchise stores.

The story goes on to report that China’s State Radio Regulatory Commission (SRRC) has given iPhone a certificate of approval on May 7, 2009. Engadget ends the post with a cute tag “So, all we need now is what’s we’ve needed for years: a handwritten note from El Jobs himself saying that this whole thing is more than some sick charade.”

No Engadget, the “charade” is something that you are perpetuating though your post. Unfortunately, the echo chamber that has replaced investigative journalism is now regurgitating your report across the Net. “iPhone approved by China!”

Two key problems with this Engadget post:

iPhone’s receipt of radio transmission certificate in not “news.”

iPhone has NOT yet been approved for sale by China’s authorities. An “official” iPhone cannot be offered for sale in China without a network access license (which could be issued any time now).

Interfax TMT reporter Cindy Ging deserves the most credit for reporting on this story. On June 11, 2009 Cindy reported that iPhone has received only one (1) of the two (2) required licenses:

The real iPhone in China news was the posting of several photos that just might be the new model iPhone – Model A1324. Here is what I posted yesterday on iPhonAsia re the new China iPhone photos > http://iphonasia.com/?p=5974

China website Sina.com.cn has posted several photos (below) of the rumored new iPhone model for China. Sina.com.cn was apparently “motivated” to later alter (blur-out) both the model number and the WCDMA (China Unicom’s 3G network) inscription showing on the backside. The use of simplified Chinese inscriptions on the iPhone backside is interesting as the iPhone model for Hong Kong uses traditional Chinese (more complex characters). Simplified Chinese is more widely used in mainland China.

Owen Fletcher at IDG News Service points out one other interesting item showing in the photos:

“The iPhone in the pictures also carries China’s ‘Environmental Protection Use Period’ mark, which indicates the number of years of normal operation during which hazardous or toxic substances included in the product will not leak or change in a way that harms the environment or human health. In the case of the iPhone pictured that length of time is 10 years.”

Are these actual photos of the iPhone code-named “Model 90” (a.k.a. A1324) rumored to be in production in at Foxconn’s factory in Shenzhen? Or are these just photoshop fakes? I’ll leave it to the Photoshop experts to dissect.

The second set of photos (below) shows China Unicom’s “中国联通” carrier signal in the top left hand corner. The battery percentage meter reveals it is a 16GB 3GS model. NOTE: The front face iPhone photos do not necessarily prove anything, as there are many iPhones (including iPhone 3GS) in China that are now in test mode on China Unicom’s WCDMA 3G network.